January 31, 2020

As we write, US stocks are down about 1.6% on the day, foreign developed market stocks are down 1.8%, and emerging market stocks are down about 2.4%. This type of corrective action did not really come as a surprise to us. Indeed just two weeks ago we wrote that New All-time Highs on Declining Breadth is Reason for Caution and our recent quarterly slide deck we went even deeper into highlighting the extraordinary level of euphoric sentiment among investors, which is typically only seen just before corrected phases begin. Stocks were ripe for risk off period, all we needed was a catalyst, which is never known ahead of time.

As it turns out, the catalyst (at least for this first leg down) has been the rapid spread of the coronavirus. China, being at the epicenter, is obviously the most acutely affected by the spread of the virus. As dangerous as the virus is, we believe financial markets face a larger risk from the impending economic slowdown the virus will create due to the massive quarantine effort of China underway. Incoming data suggests that so far the lethalness and contagiousness of the coronavirus appears less than the SARS outbreak 17 years ago. This is great news from a public health standpoint.

The massive quarantine of China is another issue. So far the Chinese government has quarantined 45 million people, or about 3.5% of the population. This would be like the US quarantining the state Georgia. What’s more, many manufactured goods are either produced or transported through the quarantined Hubei province, raising obvious questions about how effectively supply chains will function while the quarantine is underway. Finally, the number of countries halting inbound and outbound flights to China is growing by the day. The short-term ramifications on Chinese growth are large enough to pay attention to. In our view, markets are doing just that.